“Although it’s easy to forget sometimes, a share [of stock] is not a lottery ticket… it’s part-ownership of a business…” – Peter Lynch
The quote above is from the legendary mutual fund manager Peter Lynch of Fidelity who managed the Magellan Fund in the 1970s and 1980s. That statement succinctly corrects the misunderstandings that many people have about the stocks who are trying to save and invest but are reluctant to have exposure to the stock market. Many times, prospective clients come into our offices with the perception that the stock market is “just a casino.”
If it isn’t a Casino, What is it..
The stock market is the universe of companies that have listed their shares (part-ownership as Lynch states above) on a regulated market for the public to buy and sell. Like any market, if there are not enough buyers, the price of a stock may go down. In the event of a market correction or a bear market, many if not all, of the stocks in the stock market may go down, possibly below their intrinsic value.
Conversely, if there are too many buyers, like the technology bubble of the 1990s or the real estate bubble of the 2000s, stocks in these sectors may go up beyond their true value. This buying and selling can create volatility and turbulence in the short run that can discourage many savers.
So, what is the true or intrinsic value of a company? A company’s value comes from its assets and their ability to generate earnings and dividends. The key is how much an investor pays for these earnings and dividends.
As an example, we can look at the value of stock market by aggregating the earnings of the market through a proxy, such as the S&P 500 index. This is a group of 500 companies that largely reflect the characteristics of the American economy. At the time of this newsletter, the S&P 500 index was at a level of 2750. The earnings for this index are forecasted to grow by 22% to 162 in 2018 and 10% to 178 in 2019 according to Thomson Reuters I/B/E/S. This would put the stock market in a fair value range by historic standards.
Still, Not Easy to Predict
Bear in mind that the direction of the stock market is impossible to predict in the short run and corrections of 10% or more are common, and bear markets (declines of 20% or more) have occurred, on average, every four years. Further, while the market may be in a fair value range, individual companies could be substantially over-valued or under-valued.
Most importantly, the earnings for the S&P 500 index, as a whole, has grown by around 8% since the 1920s. The long-term growth in these earnings is what will drive the stock market higher in the future. This is not guaranteed but a function of capitalism and a well-run economy. It is necessary to have a long-term perspective.
We thank you very much for the trust you have placed in our firm. Please do not hesitate to contact us with any questions. Further, if your financial circumstances have changed, please call the office to set up an appointment to review your plan.
Shoreline Financial Advisors, LLC